Saving for retirement is crucial, but choosing a retirement plan that fits your needs and financial goals can be challenging. 401(k) and 403(b) are popular retirement plans with many points in common. However, you’ll need to be aware of some key differences.

This article will dive deeper into these differences to help you make better-informed decisions.

When it comes to retirement planning, you may have come across the terms "401(k)" and "403(b)" plans. These two retirement savings options are commonly discussed, but do you know their fundamental differences? In this article, we will provide you with a comprehensive overview of 401(k) and 403(b) plans, shedding light on their key characteristics and helping you better understand these retirement options. Whether you are starting your career or considering a job change, having a solid grasp of these plans can contribute to your overall financial literacy.

What is a 401(k)?

A 401(k) plan is one of the most recognizable retirement savings plans offered by for-profit companies to their employees. It is a defined contribution plan, which means that employees can elect to save a portion of their income on a pre-tax and in some cases a post-tax basis. This money is then invested in various investment options, such as mutual funds, stocks, or bonds.

The IRS sets annual contribution limits for 401(k) plans, which may change yearly. For 2023, the contribution limit is $22,500 for individuals under age 50 and $30,000 for individuals over 50. Pre-tax contributions to a 401(k) plan are tax-deferred, meaning you won't pay taxes on the money until you make a withdrawal. This can result in significant tax savings and can lower your taxable income.

401(k) plans may offer various investment options, including mutual funds, stocks, bonds, and target-date funds. Employers may also provide options for employee-directed investments or the services of a professional investment manager. However, these investment options may come with additional management fees, which can significantly impact your savings.

401(k) plans offer a range of benefits, such as tax advantages and the potential for long-term growth. However, it is essential to carefully consider the investment options and fees before selecting to ensure that it aligns with your goals and risk tolerance.

What is a 403(b)?

A 403(b) plan is a retirement savings account for certain nonprofit, education, and government employees, including public school teachers, university employees, and church workers. It is similar to a 401(k) plan, which for-profit companies offer, but it is exempt from nondiscrimination testing. Nondiscrimination testing is a process that ensures employer-sponsored retirement plans do not unfairly benefit highly compensated employees (HCEs) at the expense of non-highly compensated employees (NHCEs).

The contribution limit of a 403(b) plan is similar to a 401(k) plan - up to $22,500 for 2023 with an additional catch-up contribution of up to $7,500 for employees who are 50 or older.

A 403(b) plan offers several benefits from a tax perspective. Similar to most 401(k) plans, contributions to a 403(b) plan are made on a pre-tax basis, meaning they are tax-deductible in the year they are made. In other words, the contributions are subtracted from the employee's taxable income, which can help to reduce their overall tax bill for that year. Additionally, the money in the 403(b) account grows tax-deferred until withdrawal.

A key difference of a 403(b) plan is its investment options. Like a 401(k) plan, a 403(b) plan offers a variety of investment options, including mutual funds, target-date funds, and individual securities. However, 403(b) plans generally include annuity options. The specific investment options available can vary depending on the employer's plan and the financial institution that manages the plan.

Finally, 403(b) plans may have management fees, such as administrative fees, investment fees, and other expenses. These fees vary significantly based on the plan and the financial institution involved. It is vital for employees to understand these fees and to compare them across different investment options and accounts to help ensure that they are getting the most value from their retirement savings.

In summary, a 403(b) plan is a retirement savings account designed for certain employees in non-profit, education, and government sectors. Key features and benefits of 403(b) plans may include contribution limits, tax benefits, investment options, and fees. Understanding these factors can help employees make informed decisions about retirement savings and achieving their long-term financial goals.

401(k) vs. 403(b): Understanding the Differences

While both 401(k) and 403(b) plans are designed to help employees save for retirement, there are some key differences between the two. Here's a closer look at some of the most significant differences.

Employer Eligibility and Types of Employers

One of the most significant differences between 401(k) and 403(b) plans is the types of employers that offer them. For-profit companies may offer 401(k) plans, while nonprofit organizations and government agencies, including public schools, colleges, universities, hospitals, and religious organizations, may offer 403(b) plans.

Contribution Limits and Catch-up Provisions

The contribution limits for 401(k) and 403(b) plans are the same at $22,500 per year as of 2023. However, the catch-up provisions differ slightly. For 401(k) plans, employees who are 50 or older can make an additional "catch-up" contribution of up to $7,500 per year. For 403(b) plans, employees who are 50 or older can also make a "catch-up" contribution of up to $7,500 per year, but employees who have worked for a single 403(b)-eligible employer for 15 straight years or more may also be eligible to make an additional "catch-up" contribution of up to $3,000 for up to five years.

Investment Options and Management Fees

Both 401(k) and 403(b) plans can offer various investment options, including stocks, bonds, mutual funds, ETFs, and in some cases, annuities. The specific investment options available can vary depending on the employer's plan and the financial institution that manages the plan. Similarly, the management fees of each plan can vary significantly based on the plan and the financial institution involved. It is important for employees to understand the fees associated with their plans and to compare them to help ensure that they are getting the most value from their accounts.

Withdrawal Rules and Penalties

401(k) and 403(b) plans differ in their withdrawal rules and penalties. Employees can generally begin withdrawing from a 401(k) plan at age 59.5, and withdrawals are generally subject to income tax as ordinary income. Employees can begin withdrawing funds at age 59.5, but if they withdraw funds before age 59.5, they may be subject to both income tax and a 10% penalty. However, these rules have some exceptions, such as if the employee retires, has a financial hardship, or becomes disabled.

Tips for Evaluating and Comparing Plans

Whether your employer offers a 401(k) or a 403(b) plan, you may look at other types of retirement plans to help fund retirement. When evaluating different retirement accounts, here are some tips to keep in mind:

• Consider Your Overall Investment and Retirement Goals

• Research each plan's investment options, fees, features, and other details, and compare them side by side.

• Consider seeking professional financial advice to help you make an informed decision.

• Don't be afraid to ask questions and seek clarification on any details you're unsure of.

Selecting the right retirement plan or account requires careful consideration of factors such as eligibility, investment options, contribution limits and catch-up provisions, fees, and withdrawal rules and penalties. By weighing the pros and cons of different retirement plans, and carefully evaluating and comparing them, you can make an informed decision that best suits your long-term financial goals.

What is a Roth 401(k) or Roth 403(b), and How it Differs from the Other Retirement Accounts

When discussing retirement accounts, let us also see what a Roth 401(k) or 403(b) is and how it differs from the other two.

A Roth 401(k) and 403(b) is a retirement savings account that differs from traditional 401(k) or 403(b) accounts in that contributions are made on an after-tax basis. This means that contributions to a Roth do not provide an immediate tax deduction. Still, qualified distributions in retirement are tax-free, which can provide significant tax advantages in the future.

A Roth 401(k) or Roth 403(b) also differs from a Roth IRA, which has lower contribution limits and income eligibility requirements. While both Roth accounts offer tax-free withdrawals in retirement, a Roth 401(k) or 403(b) is offered through an employer-sponsored plan. It may provide additional benefits, such as employer-matching contributions.

In general, a Roth 401(k) or Roth 403(b) may be a good option for individuals who expect to be in a higher tax bracket in retirement or who want to have tax-free income in retirement. However, it's essential to carefully consider your individual financial situation and retirement goals before deciding whether it is right for you.

Parting Thoughts

At Cooke Wealth Management, we understand that retirement savings are crucial to securing your future financial stability. By seeking professional guidance, you can decide which retirement plan is right for you and your long-term financial well-being. As a certified independent wealth management firm dedicated to helping you worry less and enjoy life more, we are just a phone call away from helping you achieve your financial goals. Schedule a discovery session to learn how we can help you plan your retirement.